Dorfman: It may pay to let a good thing ride

Many people automatically sell half of any stock that doubles. That way, they figure, they are “playing with the house’s money” and can’t lose.

I understand the emotional appeal of this strategy, but it’s silly. The goal is to earn a good return on your entire portfolio. To do that, sometimes it pays to let your winners run.

To drive home this point, I have published five columns over the years identifying stocks that had doubled in the previous 12 months and were still cheap. I defined a stock as “cheap” if it sold for less than 15 times earnings or less than once its revenue.

The columns were published in May 2001 through 2004 and May 2006. On average, my “doubled and still cheap” lists provided a 19.7 percent total return over the next 12 months, compared with 10.9 percent for the Standard & Poor’s 500 Index.

Four of the five lists beat the index, and one (the one from 2006) trailed.

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Bear in mind that performance of my column recommendations is theoretical and doesn’t allow for trading costs or taxes. Past performance doesn’t predict future results. And the figures for my column results should never be confused with the performance of actual portfolios I manage for clients.

New Blood
Today, with the stock market looking robust again, it seems like a good time to repeat the exercise. In the 12 months preceding May 24, 2013, 114 stocks with a market value of $500 million or more doubled. Those lucky winners constitute about 4 percent of all stocks in that size range.

Under my definition, 31 of those stocks are still cheap. But some of them have puny profits or bloated debt. Here are five that I like.

Stewart Information Services (STC), based in Houston, is a leading provider of title insurance policies and real estate information. It is reviving with the housing market.
In 2006 Stewart broke $50 a share. Then in the financial crisis of 2008 it fell below $7. Today it trades at about $29, which is fewer than six times earnings.

Phillips 66 (PSX), which also calls Houston home, is a large refining company spun out of ConocoPhillips last year. It trades for fewer than seven times earnings. Should you invest, you would be in good company: Warren Buffett’s Berkshire Hathaway owned some 27 million shares, according to a March filing.

Another refiner that has doubled and still looks cheap to me is Tesoro Corp. (TSO), which is located in San Antonio and has a chain of gas stations in the western United States

I have owned Tesoro for clients a couple of times in the past. I have no position currently, but am evaluating whether to re-establish one. The stock sells for a little more than seven times earnings.

Orbitz Worldwide (OWW) is an online travel company, with headquarters in Chicago. It competes with larger rivals such as Priceline.com. (PCLN), Expedia (EXPE) and Travelocity Holdings (privately held). All of these companies have a love-hate relationship with the airlines and hotels they deal with.

The airlines and hotels would like to cut out the middlemen and keep more of the revenue. But they know that travelers value the convenience and comparative objectivity of the online sites.

Orbitz is a speculative pick. The company lost money each year since it went public in 2007, but it is expected to show its first profit this year.

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My final pick is First Solar of Tempe, Ariz., an extremely unpopular stock.
The maker of solar panels draws only three “buy” recommendations from the 27 analysts who follow it. Ten call it a “sell.”

Heavy competition from China and Japan in solar panels keeps investors cautious. They also worry that the solar industry relies on government subsidies that could be withdrawn. And they fret that there is a glut of solar-panel capacity.

I think that these concerns are adequately discounted in the stock’s valuations — nine times earnings, 1.2 times revenue and 1.2 times book value (corporate net worth per share).

Time to sell
Some other well-known stocks have doubled in the past year, but I can’t recommend them. Gilead Sciences (GILD) is now too pricey in my opinion, though I liked it at lower prices.

Sprint Nextel (S) is headed for its seventh consecutive loss year.
Avis Budget Group (CAR) has way too much debt for my taste.
Netflix (NFLX) has had a great year, up 161 percent. But as I wrote in last week’s column, I consider its valuation ridiculous, at 331 times earnings. I wouldn’t touch the stock with a 10-foot pole. John Dorfman is chairman of Thunderstorm Capital LLC in Boston. His firm or its clients may own or trade securities discussed in this column. He can be reached at jdorfman@thunderstormcapital.com.